Why is it important for insurance companies to have a large pool of people paying premiums?

• A. It allows the company to spread risk across many individuals, reducing the impact of large claims.
• B. It guarantees that every policyholder will receive more in claims than they pay in premiums.
• C. It enables the company to avoid government regulation.
• D. It ensures that only high-risk individuals are insured.

Answer: (A)

Verified step by step guidance

1. Understand the concept of risk pooling in insurance: Insurance companies collect premiums from many individuals to create a large pool of funds.
2. Recognize that risk pooling allows the insurer to spread the financial risk of large claims across many policyholders, rather than concentrating it on a few.
3. Know that by having a large number of people paying premiums, the insurer can predict overall losses more accurately using the law of large numbers.
4. Realize that this spreading of risk reduces the financial impact on the company when some individuals make large claims, helping maintain stability.
5. Conclude that this is why insurance companies prefer a large pool of insured individuals, as it helps them manage risk effectively and keep premiums affordable.